Forex: AUD/USD – Love/hate relationship with US 10-year yields

on Dec 10, 2013
Updated: Oct 21, 2019
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**iNVEZZ.com, Tuesday 10 December:**

Global financial markets are now totally focused on the US Federal Reserve’s 17-18 December monetary policy meeting, with the belief widespread that the FOMC may decide at that meeting to begin tapering its quantitative easing programme.
In a speech yesterday, St Louis Fed president James Bullard said that “based on labour-market data alone, the probability of a reduction in the pace of asset purchases [in December] has increased.” Bullard indicated that he personally favours a modest taper initially because it will provide “the Committee the opportunity to carefully monitor inflation during the first half of 2014”.

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Bullard has been a keen proponent of maintaining QE throughout 2013 because of the stubbornly low rate of inflation in the US. His open support for a December start to tapering suggests that the Fed may be very close to trimming stimulus as early as next week. The fact that this will be Bullard’s final vote on the FOMC, at least for now, may or may not prove significant.

“So what does this all mean for Australia?” ask analysts at National Australia Bank (NAB). “Firstly, if the Fed can commence to wind back its stimulus program, this signals the ‘all clear’ for the US recovery – great news for the global economy, given that America is still by far the largest economy on the planet.” NAB’s economists add that for a medium sized trading nation like Australia, this is going to be “very positive for exports”.

There is also an implication for the US bond market because as the Fed eases its asset buying, the yield of long-term US T-bonds will rise. In fact, this has already happened to some extent and the Australian dollar has been impacted by the dynamics in US Treasuries.
“Higher US bond yields have been attracting money back to the US, taking advantage of the higher rates”, explains NAB. “To do so, foreigners needed US dollars, bidding the US dollar higher.” A stronger greenback means a lower aussie, with the left chart below showing the recent striking correlation between 10-year US bond yields (inversed) and the AUD/USD.

NAB’s analysts conclude that tapering talk has played some part in the depreciation of the Australian dollar in 2013 and “there’s likely to be some more of that”, with the bank expecting the AUD/USD to slip to around 0.8500 next year.
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If 10-year US bond yields are such an important driver for the AUD/USD, traders in the pair probably need a dedicated bond specialist to help them navigate through the shifting tides in Treasuries. A much lower-cost option is highlighted in the right chart above compiled by Aurelija Augulyte, senior FX analyst at Nordea Markets, which monitors developments in the EUR/AUD pairing.
Since late 2011 the correlation between 10-year T-bill yields and EUR/AUD has been more than 90 percent. This year though, price action in the pair has led long-term US yields by roughly two weeks. If the lock-step movement continues, 10-year yields should test the 3.0 percent mark by year-end and the AUD/USD could drop to its three-year low of 0.8848.
NAB’s Australian Business Confidence for November checked in earlier today at 5, marginally below October’s figure of 6, revised up from 5 also.
At 23.30 UTC today, Westpac’s Australian Consumer Sentiment is due out. The prior reading showed a gain of 1.9 percent.
Right now, the AUD/USD is trading 0.9094, down 0.17 percent intraday.
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